Restricted Stock

Restricted Stock

Key takeaways
* Restricted stock are company shares granted to employees that carry transfer and sale restrictions until certain conditions are met.
* Vesting schedules (time-based or performance-based) determine when the shares become transferable and taxable.
* Two common forms are Restricted Stock Awards (RSAs) — actual shares granted at award — and Restricted Stock Units (RSUs) — promises to deliver shares later.
* Tax treatment: restricted stock is generally taxed as ordinary income at vesting, but an 83(b) election can change the timing (with tradeoffs).

What is restricted stock?
Restricted stock refers to company shares issued to employees, executives, or directors subject to conditions that limit transferability and sale. These conditions typically include a vesting schedule tied to continued employment or the achievement of performance milestones. The restrictions protect the company from immediate resale that could depress the stock price and create an incentive for employees to stay and contribute to long‑term value.

How restricted stock works
* Grant: The company awards restricted shares (or units) specifying vesting conditions.
* Vesting: Shares remain nontransferable until conditions are met. Vesting can be time-based (e.g., graded over several years) or performance-based (e.g., hitting revenue targets).
* Settlement: Once vested, the holder receives shares (or the right to receive shares) that can be sold, subject to any insider-trading rules or resale restrictions.
* Forfeiture: If vesting conditions are not met (employee departs early, misses targets, or violates policies), unvested shares are typically forfeited.

RSUs vs RSAs
* Restricted Stock Units (RSUs): A promise to deliver shares (or cash equivalent) in the future. RSUs are not actual shares until settlement, so they normally carry no voting rights and cannot generally be the subject of an 83(b) election.
* Restricted Stock Awards (RSAs): Actual shares issued at grant but subject to forfeiture until vesting. Because the employee receives the shares immediately (albeit subject to restrictions), RSAs typically carry voting rights and can be eligible for an 83(b) election.

Restricted stock vs. stock options
* Ownership vs. option: Restricted stock delivers (or promises) actual shares; stock options give the right to buy shares at a set exercise price.
* Cost to employee: Restricted stock usually requires no outlay to receive shares at vesting. Options typically require payment of the exercise price to obtain shares.
* Tax timing: Restricted stock generally triggers ordinary income tax at vesting (or at grant if an 83(b) election is made). Incentive stock options and nonqualified options have different tax events (exercise, disqualifying disposition, sale), so timing and tax rates can differ.
* Risk/reward: Options can offer higher leverage (large upside but can become worthless if stock falls below strike). Restricted stock retains some value even if the stock declines.

Tax treatment and the 83(b) election
* Default treatment: At vesting, the fair market value (FMV) of the shares (minus any amount paid by the employee) is taxed as ordinary income. The employer typically must withhold payroll taxes at that time.
* 83(b) election: An employee who receives actual restricted shares (typically RSAs) can choose to file an 83(b) election within 30 days of grant. This causes ordinary income to be recognized based on the FMV at grant rather than at vesting. Potential benefits and risks:
– Benefit: If the stock appreciates significantly before vesting, future gains after the election may be taxed at capital gains rates upon sale rather than as ordinary income.
– Risk: If the shares are forfeited before vesting, taxes already paid are generally nonrefundable.
– Timing: The election must be filed with the IRS within 30 days of grant; late elections are not accepted.
* RSUs: Because RSUs are not property at grant, they generally do not qualify for an 83(b) election.

Other legal and resale considerations
* SEC Rule 144 and similar rules limit how and when insiders may resell restricted securities—holding periods and volume limits may apply for public-company restricted shares.
* Private-company restricted stock often has limited liquidity; even vested shares may be hard to sell until a liquidity event (e.g., IPO or acquisition).
* “Double-trigger” acceleration clauses are common in M&A: vesting accelerates only if a company is acquired and the employee is terminated (both triggers must occur).

Advantages
* Simple and tangible form of equity compensation that aligns employee and company interests.
* No cash outlay required to receive shares at vesting.
* Can encourage retention and performance; retains some value even in down markets.

Disadvantages
* Taxation upon vesting can create cash-flow burdens (tax due before shares are sold).
* Unvested shares may be forfeited if employment ends.
* Voting rights and dividends may be limited until vesting (especially for RSUs).

Practical tips
* Understand the vesting schedule, any performance conditions, and what happens on termination, disability, or change of control.
* Evaluate liquidity: know whether and when vested shares can realistically be sold.
* If offered an 83(b) opportunity, consult a tax advisor — assess likely appreciation, personal cash to pay the tax, and forfeiture risk.
* Consider overall asset allocation and tax planning when deciding whether to hold or sell vested shares.

Conclusion
Restricted stock is a widely used form of equity compensation that grants employees an ownership stake in the company while imposing conditions to encourage retention and alignment with corporate goals. Understanding the differences between RSUs and RSAs, the tax implications (especially the 83(b) election), and the practical liquidity and forfeiture risks is essential to make informed decisions about accepting, holding, or selling restricted shares.